By Alex Salkever The success of Apple's retail stores has been one of the most surprising chapters in the feel-good story of the Think Different company's comeback. When the retail outlets were launched in 2001, analysts howled that CEO Steve Jobs was pouring money into a black hole. Now, one-time doubter and Apple (AAPL) bear Steve Milunovich of Merrill Lynch says the retail risk has passed. According to Apple, the chain has been profitable for two consecutive quarters, and it expects to see margins rise from 2% to 5% as customer traffic continues to increase.
Not everyone is smiling, however. Tony Verga, who owns CDS Group, a certified Apple dealer and consultant in Phoenix, has been selling Macs and providing Mac-centric consulting services for nine years. When Apple opened two stores in the Phoenix area in 2002, Verga saw an immediate impact on his business. Apple had previously referred service calls to CDS. But increasingly, Apple refers service customers to its own retail operations, claims Verga. "My guess is that they want to do it all," he says, estimating that his business is down by at least 10% since those stores opened.
Verga is one of a growing number of smaller third-party Apple resellers crying foul. Five particularly aggrieved resellers have filed a lawsuit in California's Santa Clara County Superior Court alleging that Apple gives its own stores preferential access to hot products and lower wholesale prices.
PAIN-RELIEF FORMULA. Two of the complainants, Thomas Armes and Tom Santos, are seeking to recruit more Apple resellers for the suit via a damning Web site, TellonApple.org, and a number of Apple resellers with whom I spoke are thinking about adding their names to list of plaintiffs. Armes, who claims he was the second-largest independent U.S. reseller, closed his five-store chain and laid off 75 employees in the spring of 2003, in the wake of a contract dispute with Apple. While Apple declines to comment on pending litigation, executives have stated repeatedly that independent resellers get the same treatment as Apple stores.
By alienating folks like Verga and Armes, who have been the backbone of Apple's distribution network for the past 30 years, Jobs & Co. are skating on thin ice. The new stores are essential to Jobs's strategy. As Apple moves away from selling only Macs to become more of a consumer-electronics company, the stores are a critical way to leverage Apple's brand and showcase newfangled digital wares to affluent consumers. But independent resellers still account for more than 50% of Apple's domestic sales. Should they abandon the outfit in a huff, Apple could suffer.
What should Jobs & Co. do? Apple must craft a plan to rebuild and reinvent its ties with small resellers. First, it needs to be honest and admit that Apple stores are hurting the resellers' business and that not all of them will survive. Second, Apple has to treat those that do hang on as integral parts of its organization and sales effort. Finally -- and most crucial -- Apple needs to ease the pain by coming up with programs to encourage these longtime partners to help it accomplish goals it can't achieve on its own.
WHERE'S THE PROOF? For example, Apple could award higher commissions and faster restocking to resellers that make deals to sell, say, 10 or more of the new X-serve servers. Or it could offer a special bonus for orders placed through resellers by large corporations, a target market for Apple. That way, people like Verga might once again see a prosperous future in working with Apple, thereby furthering Jobs's goals as well.
To date, Apple has denied that its policies are hurting resellers. Apple retail guru Ron Johnson contends that the company has evidence that third-party dealers located close to an Apple store actually benefit from a symbiotic relationship. But when I asked an Apple spokeswoman for those numbers, she was unable to provide them.
Apple's own publicly reported numbers tell a clear tale, however. Revenue growth from the stores has outpaced total revenue growth. Retail sales have increased by more than 900% from December, 2002, to March, 2004, and Apple says it now does one-third of all repairs in its stores. Those are repairs the third-party folks can no longer do.
HP'S MODEL. "The Mac market has not grown dramatically, and the Apple stores now represent a third of all U.S. retail business. That had to come from other third-party retail outlets," says Charles Wolf, an analyst with investment bank Needham & Co.
"Apple should say, 'We need those added profits that we can get from selling direct. We think that as a company it benefits us. But we also think it benefits us to have other distribution points, too,'" says Steve Baker, a retail tech analyst with NPD Group. This is hardly unprecedented. Hewlett-Packard (HPQ) has built a direct-sales business while maintaining strong relationships with resellers, says Baker. It has done this by ensuring that resellers had plenty of opportunities to make money, either by bundling low-margin PCs with higher-margin HP printers or by giving resellers higher margins on iPaq handheld computers.
Originally, Apple's stores were supposed to showcase and sell products. Then Apple added repairs to the list of services. Next came ProCare, a $99 per-year premium subscription that gives purchasers next-day repairs and consultations with Apple specialists working at the stores' Genius Bar. Verga says customers have told him that Apple store reps have been leaving the premises to make outside sales calls.
GOOD HAND-HOLDERS. No surprise, then, that the small resellers that have provided all of these things in the past now feel they have bull's-eyes on their backs. Rather than keep moving the line between its stores and the resellers, Apple needs to set some boundaries and give resellers space to run their businesses.
Many of the independent resellers service creative outfits and advertising shops, which remain Apple's bread and butter. These customers are more likely to buy higher-price professional Macs and other big-ticket items, but they need far more hand-holding than the average customer. Also, while Apple takes on more of the basic repair business, it should leave high-end software consulting to partners. If the Apple store doesn't have a Mac-centric product that a reseller might stock, it should point the customer to that reseller.
Also, new business possibilities have opened up because of changes in Apple's own product lines, such as servers, data-storage systems, and high-end software. Logically, the best customers for these new offerings will be existing Apple customers in the creative fields already serviced by independent resellers.
SURVIVAL OF THE FITTEST. Or how about training resellers to offer in-home installation of Wi-Fi stereo systems using Apple's new AirPortExpress wireless broadband routers and iTunes software? "You have to have some evangelists and feet on the street," says NPD's Baker. "A lot of businesses are reluctant to buy from a big, nameless, faceless corporation somewhere. They're not going to have 600 Apple stores in every corner of the country. They need to use the resellers and the retailers to fill in those gaps."
Of course, Apple can't and shouldn't pretend to guarantee the survival of all small resellers. Many will get out of the business -- and they should. Viewed as a whole, small resellers have failed to build Apple's market share and its brand. But throwing out the good resellers with the bad would cost Apple a huge amount of customer goodwill.
Unless Jobs & Co. think through the logical next step of their retail strategy and figure out a way to keep those small, valuable resellers in the fold, Apple could lose leverage in some of its most lucrative markets -- and seriously damage the company's overall ecosystem. Salkever is Technology editor for BusinessWeek Online